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Perspective From Franklin Templeton InvestmentsTue, 03 Mar 2015 14:22:26 +0000en-UShourly1http://wordpress.org/?v=3.8.5Notes From The Trading Desk – Europehttp://global.beyondbullsandbears.com/2015/03/02/notes-trading-desk-europe-2/
http://global.beyondbullsandbears.com/2015/03/02/notes-trading-desk-europe-2/#commentsMon, 02 Mar 2015 17:16:39 +0000http://global.beyondbullsandbears.com/?p=7376Franklin Templeton’s Notes From The Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice. Monday 2nd March Global equity strength continued last week with several global stock markets reaching record levels, although the United States, hovering just below all-time highs, did not join the party. For Europe, positive economic data and the upcoming launch of the European Central Bank’s (ECB) quantitative easing (QE) programme in March, as well as the extension of Greece’s bailout for four months, helped equities surge to multi-year highs. In the United States, focus was on Federal Reserve (Fed) Chair Janet Yellen’s Congressional testimony, as well as on mixed economic data. Yellen Testimony Brings Fed Policy Into Focus Fed Chair Janet Yellen’s testimony to Congress last week provided one of the main talking points for the week as her words were scrutinised for any clues regarding the Fed’s thinking on the normalisation of interest rate policy. Broadly speaking, her testimony largely reiterated the tone and content of the Federal Open Market Committee (FOMC) minutes from the January meeting. She stressed that the Fed’s assessment that it can be patient in beginning to normalise policy, which means that economic conditions are unlikely to warrant a tightening for the next couple of meetings. Yellen added that the Fed would likely change its forward guidance language before raising rates. However, she also noted that any modification would not necessarily mean that lift-off would take place for a couple of meetings. Instead, it would indicate that a move could be warranted at any meeting. These comments were taken as a reference to the potential removal of the word “patient” from the next Fed statement when talking about timing on normalisation of rates. In our view it appears she is laying the groundwork for this change of terminology but trying to retain as much flexibility as possible regarding rate normalisation. Yellen again reiterated that policy changes remain dependent on employment and inflation data, although she reiterated her view that there is no evidence inflation is likely to move above 2% anytime soon. We think the focus now is likely to be on the next Fed meeting on March 17 and 18 and on any Fed committee speakers ahead of that. We expect this to be a key market for focus over the next quarter or so. Greece – Bailout Extension Approved A four-month extension to Greece’s bailout was approved last week after Greece was able to provide a draft of reform proposals to its creditors that would provide a ‘starting point’. The new Greek government agreed to certain “concessions” (pension liberalisation, better tax collection, a promise not to roll back completed privatisations) in order to obtain the extension. The International Monetary Fund (IMF) and the ECB both raised some reservations due to the lack of clarity in some tax and welfare reforms. IMF Chief Christine Lagarde said the list lacked “clear assurances that the government intends to undertake the reforms envisaged”. However, it was accepted by Greece’s creditors and this gives them an extension to the existing bailout for four months. Over this period negotiations will take place to agree a path forward for Greece and this will no doubt see some tough discussions ahead. It is also important to remember that Spanish elections are scheduled for later in the year and left wing party Podemos are continuing to poll well on the back of their anti-austerity/bailout policies. We believe in this regard the talks over Greece’s bail out may set an important precedent. Looking ahead, while the extension agreed last week provides some respite, we would expect Greece to remain in focus over the rest of the second quarter of 2015 as negotiations commence on what will most likely be a third bailout. Positioning Ahead of ECB QE We can see much evidence of positioning ahead of the ECB QE programme which is due to start on March 9. European equities last week surged higher and eurozone bond markets performed well with record low yields in a number of benchmarks. The periphery registered the biggest moves, which we interpreted as positioning ahead of the start of the ECB’s sovereign QE programme this month. Last week’s global fund flow data showed further inflows into European equities, meaning the inflows over past eight weeks have been the largest since December 2008. In contrast we have seen US equity funds suffer outflows in seven out of the past eight weeks. Europe Aside from the support of another week of strong inflows into European equities, a weakening Euro, and the diminishing of short-term tail risks from the Greek bailout situation, a further supportive factor for the regions stock markets was improvement in eurozone macro fundamentals. Friday saw the release of some of the February preliminary eurozone CPI data, which came in better than expected, with Germany and Italy the particular bright spots. German and Spanish GDP arrived in line–with the latter registering its 6th straight quarter of growth. In his more hawkish testimony to the Treasury Select Committee, Bank of England (BoE) Governor Mark Carney said that the monetary policy committee could look beyond the current bout of weak inflation as he pledged to return price growth to target “within a reasonable horizon.” Americas There were few notable directional influences on the market in a busy week of Fedspeak which added to an already extremely nuanced lift-off timing debate, but overall it seemed to have relatively little impact on overall policy normalization expectations. Consumer stocks were among the best performers, while the energy, utilities and industrials sectors all finished the week down. Energy was the worst performer last week. Asia Over the weekend, the Peoples Bank of China (PBoC)...]]>

Franklin Templeton’s Notes From The Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

Monday 2nd March

Global equity strength continued last week with several global stock markets reaching record levels, although the United States, hovering just below all-time highs, did not join the party. For Europe, positive economic data and the upcoming launch of the European Central Bank’s (ECB) quantitative easing (QE) programme in March, as well as the extension of Greece’s bailout for four months, helped equities surge to multi-year highs. In the United States, focus was on Federal Reserve (Fed) Chair Janet Yellen’s Congressional testimony, as well as on mixed economic data.

The Digest

Yellen Testimony Brings Fed Policy Into Focus

Fed Chair Janet Yellen’s testimony to Congress last week provided one of the main talking points for the week as her words were scrutinised for any clues regarding the Fed’s thinking on the normalisation of interest rate policy. Broadly speaking, her testimony largely reiterated the tone and content of the Federal Open Market Committee (FOMC) minutes from the January meeting.

She stressed that the Fed’s assessment that it can be patient in beginning to normalise policy, which means that economic conditions are unlikely to warrant a tightening for the next couple of meetings.

Yellen added that the Fed would likely change its forward guidance language before raising rates. However, she also noted that any modification would not necessarily mean that lift-off would take place for a couple of meetings. Instead, it would indicate that a move could be warranted at any meeting. These comments were taken as a reference to the potential removal of the word “patient” from the next Fed statement when talking about timing on normalisation of rates.

In our view it appears she is laying the groundwork for this change of terminology but trying to retain as much flexibility as possible regarding rate normalisation.

Yellen again reiterated that policy changes remain dependent on employment and inflation data, although she reiterated her view that there is no evidence inflation is likely to move above 2% anytime soon.

We think the focus now is likely to be on the next Fed meeting on March 17 and 18 and on any Fed committee speakers ahead of that. We expect this to be a key market for focus over the next quarter or so.

The new Greek government agreed to certain “concessions” (pension liberalisation, better tax collection, a promise not to roll back completed privatisations) in order to obtain the extension. The International Monetary Fund (IMF) and the ECB both raised some reservations due to the lack of clarity in some tax and welfare reforms. IMF Chief Christine Lagarde said the list lacked “clear assurances that the government intends to undertake the reforms envisaged”.

However, it was accepted by Greece’s creditors and this gives them an extension to the existing bailout for four months. Over this period negotiations will take place to agree a path forward for Greece and this will no doubt see some tough discussions ahead.

It is also important to remember that Spanish elections are scheduled for later in the year and left wing party Podemos are continuing to poll well on the back of their anti-austerity/bailout policies. We believe in this regard the talks over Greece’s bail out may set an important precedent.

Looking ahead, while the extension agreed last week provides some respite, we would expect Greece to remain in focus over the rest of the second quarter of 2015 as negotiations commence on what will most likely be a third bailout.

Positioning Ahead of ECB QE

We can see much evidence of positioning ahead of the ECB QE programme which is due to start on March 9. European equities last week surged higher and eurozone bond markets performed well with record low yields in a number of benchmarks.

The periphery registered the biggest moves, which we interpreted as positioning ahead of the start of the ECB’s sovereign QE programme this month. Last week’s global fund flow data showed further inflows into European equities, meaning the inflows over past eight weeks have been the largest since December 2008.

In contrast we have seen US equity funds suffer outflows in seven out of the past eight weeks.

Last Week

Europe

Aside from the support of another week of strong inflows into European equities, a weakening Euro, and the diminishing of short-term tail risks from the Greek bailout situation, a further supportive factor for the regions stock markets was improvement in eurozone macro fundamentals. Friday saw the release of some of the February preliminary eurozone CPI data, which came in better than expected, with Germany and Italy the particular bright spots. German and Spanish GDP arrived in line–with the latter registering its 6th straight quarter of growth.

In his more hawkish testimony to the Treasury Select Committee, Bank of England (BoE) Governor Mark Carney said that the monetary policy committee could look beyond the current bout of weak inflation as he pledged to return price growth to target “within a reasonable horizon.”

Americas

There were few notable directional influences on the market in a busy week of Fedspeak which added to an already extremely nuanced lift-off timing debate, but overall it seemed to have relatively little impact on overall policy normalization expectations. Consumer stocks were among the best performers, while the energy, utilities and industrials sectors all finished the week down. Energy was the worst performer last week.

Asia

Over the weekend, the Peoples Bank of China (PBoC) cut benchmark interest rates for the second time in three months. The PBoC also increased the deposit-rate ceiling to 1.3 times from 1.2, meaning banks can pay a larger margin over the benchmark.

Overall, Japanese data disappointed, in our view. Household spending fell for the 10th straight month, while the drop in retail sales was worse than expected. CPI figures, the most closely monitored metric for its potential implication on Bank of Japan policy, were similarly unimpressive.

Week Ahead

Monetary Policy: We expect the ECB meeting this week to be in focus in light of the surge in Euro area government prices into the start of the sovereign bond QE programme. It is widely expected that the ECB will announce that it will start sovereign purchases the week of March 9.

Economics: In Europe we get final February purchasing manager indexes (PMIs) with the country breakdowns. Other highlights will be German January factory orders and industrial production and we also get to see if the very high consumer confidence readings we are seeing from the eurozone area are translating into higher retail sales which are due on Wednesday. In the United States, this week’s personal consumption expenditure (PCE) January data will be important while we also look out for US February non-farm payroll/labour data.

Views You Can Use

Insight From Our Investment Professionals

While some forecasters predict gloomy global growth this year, the contrarian-minded Dr. Michael Hasenstab, chief investment officer, Templeton Global Macro Group (formerly known as Templeton Global Bond Group), has a different view. He aims to counter what he sees as “excessive pessimism” surrounding the global economy and outlines why he believes the recent plunge in oil prices could prove a tailwind, not only for economic growth in the United States, but also in Europe. He also offers his scorecard regarding Japan’s monetary policy experiment dubbed “Abenomics.” Read more.

For long periods of time, the markets can advance relatively smoothly until a sudden onset of chaos occurs, a “tipping point” that quickly changes the picture. Some might say the recent drop in oil would be a case in point. Brooks Ritchey, senior managing director at K2 Advisors, Franklin Templeton Solutions, explores the tipping points that trigger dramatic market turns, and ponders whether he thinks global equities may be teetering on the edge of one today. Read more.

This year we expect the divergence in monetary policy among the world’s central banks to be a key theme and a likely driver of asset flows. For now, the scorecard seems to be tilted toward monetary easing since in the first month of 2015 alone, 14 central banks engaged in some form of monetary policy loosening, generally in the form of interest rate cuts or asset purchases. Read more.

Multi-asset portfolios have attracted interest around the world in recent years as investors have sought new ways to try to capture equity-like returns with less volatility. Many of these approaches have focused on traditional asset allocation methods such as shifting between stocks, bonds and cash. However, Toby Hayes, vice president and portfolio manager, Franklin Templeton Solutions, is using a different strategy, one that makes use of a larger toolkit to seek out value based on diversifying the risk factors, not the asset class. Read more.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of March 2, 2015, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton Investments. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security.

Nothing in this document may be relied upon as investment advice or an investment recommendation.

Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

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]]>http://global.beyondbullsandbears.com/2015/03/02/notes-trading-desk-europe-2/feed/0Hasenstab on Global Growth: Headwinds or Tailwinds?http://global.beyondbullsandbears.com/2015/02/26/hasenstab-global-growth-headwinds-tailwinds/
http://global.beyondbullsandbears.com/2015/02/26/hasenstab-global-growth-headwinds-tailwinds/#commentsFri, 27 Feb 2015 00:22:41 +0000http://global.beyondbullsandbears.com/?p=7382While some forecasters predict gloomy global growth this year, the contrarian-minded Dr. Michael Hasenstab, chief investment officer, Templeton Global Macro Group (formerly known as Templeton Global Bond Group), has a different view. He aims to counter what he sees as “excessive pessimism” surrounding the global economy and outlines why he believes the recent plunge in oil prices could prove a tailwind, not only for economic growth in the United States, but also in Europe. He also offers his scorecard regarding Japan’s monetary policy experiment dubbed “Abenomics.” Michael Hasenstab, Ph.D. Executive Vice President, Chief Investment Officer Portfolio Manager Templeton Global Macro Group* Excessive pessimism characterizes the current view on the global growth outlook, in our view. Many observers see the lowering of global growth forecasts by the World Bank and the International Monetary Fund (IMF) as confirming a loss of global economic momentum. Some of this pessimism also reflects a mistaken interpretation of the reasons behind the recent sharp decline in oil prices, and of its likely consequences. Many analysts and commentators have argued that the plunge in oil prices reflects the slowing down of the global economy, and some believe that the decline in oil prices itself will have a negative impact on global growth, by reducing energy investment and causing deflation in some regions. As for key economic areas, while most observers are more upbeat on the United States, many observers seem to expect a major slowdown in China and to view the eurozone as being on the brink of recession. However, even the latest IMF forecasts, which have generated so many pessimistic headlines, show the global economy accelerating, not decelerating. The IMF argues that the weakening of global oil demand is due to a loss of momentum concentrated in emerging markets, which have a higher energy intensity than advanced economies. But the slowdown in emerging markets overall has been marginal, and, most importantly, China’s oil demand continued to rise through the end of 2014. Some of the risk aversion that we have been seeing recently in the markets really dates back to late last year, and we believe a lot of it has to do with a market misread of the decline in oil prices. There are three things that we think the market has misinterpreted. The first relates to whether the fall in oil prices is due to a decline in demand or a change in supply. If it is due to a decline in demand, we think there would be reason to be bearish about the outlook for risk assets, in line with a slower global growth environment. However, it’s our assessment that the price of oil today is largely a function of change in supply due to political reasons, particularly driven by Saudi Arabia and the Organization of the Petroleum Exporting Countries (OPEC). As a result, we believe investors should think about the changing price of oil as essentially a large global tax cut to the world of oil importers. If we look at most of the major economies—China, the United States, Europe and Japan—they are all large users of oil and, as a result, will likely benefit from lower oil prices. We think the fact that the decline in the price of oil appears predominantly driven by supply factors could actually be a tailwind for the global economy in 2015. The second has to do with the sequencing of effects. In the United States, for example, the initial reaction to the plunge in oil prices could be a decrease in investment and some loss of jobs in oil-intensive sectors. But those should be shorter-term effects that we believe ultimately should be reversed over the course of the year as resources get redeployed from oil-intensive sectors to other sectors of the economy, and as those de facto tax cuts (lower oil costs) to the US consumer begin to take hold. So by the middle or end of 2015, we expect the effects of these changing dynamics in the oil markets to actually have an aggregate positive impact on the United States, as well as globally, based on similar dynamics. Investment and employment in the energy sector play a much smaller role in the economy than overall personal consumption, which accounts for about 70% of gross domestic product (GDP). We estimate that, on net, lower oil prices should add about 0.7 percentage points to US growth on an annual basis. China, as the world’s largest importer of oil, will also be an important beneficiary of lower energy prices. This should help further mitigate the current mild and healthy slowdown, so that we expect 2015 growth of about 7%, only marginally slower than last year. Importantly, the quality of investment has improved, albeit at a slower rate. This combined with a growing level of consumption as a contribution to growth puts China on a path toward the long sought after rebalancing. We would also observe that as China’s economy has grown substantially over the past decade, even at a more moderate growth rate its total contribution to global growth will remain larger than that of the United States. If China grows at 7% in 2015, the quantum of demand it produces for world GDP will also be larger than in the prior year. The third dynamic has to do with inflation. Oil is a big input within headline inflation statistics, so obviously, a 50% fall in the price of oil would be reflected in the rapid decline in headline inflation. However, we see this as more temporary in nature. Unless the price of oil falls another 50% from where it is currently, these effects will likely roll off by the end of this year, and the underlying dynamics of improving demand should actually start to reverse some of the inflation numbers. So, we think the market may be getting lulled into a sense of comfort as headline inflation numbers have been coming down. We don’t expect that to last, and believe investors should be very wary of...]]>

While some forecasters predict gloomy global growth this year, the contrarian-minded Dr. Michael Hasenstab, chief investment officer, Templeton Global Macro Group (formerly known as Templeton Global Bond Group), has a different view. He aims to counter what he sees as “excessive pessimism” surrounding the global economy and outlines why he believes the recent plunge in oil prices could prove a tailwind, not only for economic growth in the United States, but also in Europe. He also offers his scorecard regarding Japan’s monetary policy experiment dubbed “Abenomics.”

Excessive pessimism characterizes the current view on the global growth outlook, in our view. Many observers see the lowering of global growth forecasts by the World Bank and the International Monetary Fund (IMF) as confirming a loss of global economic momentum. Some of this pessimism also reflects a mistaken interpretation of the reasons behind the recent sharp decline in oil prices, and of its likely consequences. Many analysts and commentators have argued that the plunge in oil prices reflects the slowing down of the global economy, and some believe that the decline in oil prices itself will have a negative impact on global growth, by reducing energy investment and causing deflation in some regions. As for key economic areas, while most observers are more upbeat on the United States, many observers seem to expect a major slowdown in China and to view the eurozone as being on the brink of recession.

However, even the latest IMF forecasts, which have generated so many pessimistic headlines, show the global economy accelerating, not decelerating. The IMF argues that the weakening of global oil demand is due to a loss of momentum concentrated in emerging markets, which have a higher energy intensity than advanced economies. But the slowdown in emerging markets overall has been marginal, and, most importantly, China’s oil demand continued to rise through the end of 2014.

Some of the risk aversion that we have been seeing recently in the markets really dates back to late last year, and we believe a lot of it has to do with a market misread of the decline in oil prices. There are three things that we think the market has misinterpreted.

The first relates to whether the fall in oil prices is due to a decline in demand or a change in supply. If it is due to a decline in demand, we think there would be reason to be bearish about the outlook for risk assets, in line with a slower global growth environment. However, it’s our assessment that the price of oil today is largely a function of change in supply due to political reasons, particularly driven by Saudi Arabia and the Organization of the Petroleum Exporting Countries (OPEC). As a result, we believe investors should think about the changing price of oil as essentially a large global tax cut to the world of oil importers. If we look at most of the major economies—China, the United States, Europe and Japan—they are all large users of oil and, as a result, will likely benefit from lower oil prices. We think the fact that the decline in the price of oil appears predominantly driven by supply factors could actually be a tailwind for the global economy in 2015.

The second has to do with the sequencing of effects. In the United States, for example, the initial reaction to the plunge in oil prices could be a decrease in investment and some loss of jobs in oil-intensive sectors. But those should be shorter-term effects that we believe ultimately should be reversed over the course of the year as resources get redeployed from oil-intensive sectors to other sectors of the economy, and as those de facto tax cuts (lower oil costs) to the US consumer begin to take hold. So by the middle or end of 2015, we expect the effects of these changing dynamics in the oil markets to actually have an aggregate positive impact on the United States, as well as globally, based on similar dynamics. Investment and employment in the energy sector play a much smaller role in the economy than overall personal consumption, which accounts for about 70% of gross domestic product (GDP). We estimate that, on net, lower oil prices should add about 0.7 percentage points to US growth on an annual basis.

China, as the world’s largest importer of oil, will also be an important beneficiary of lower energy prices. This should help further mitigate the current mild and healthy slowdown, so that we expect 2015 growth of about 7%, only marginally slower than last year. Importantly, the quality of investment has improved, albeit at a slower rate. This combined with a growing level of consumption as a contribution to growth puts China on a path toward the long sought after rebalancing. We would also observe that as China’s economy has grown substantially over the past decade, even at a more moderate growth rate its total contribution to global growth will remain larger than that of the United States. If China grows at 7% in 2015, the quantum of demand it produces for world GDP will also be larger than in the prior year.

The third dynamic has to do with inflation. Oil is a big input within headline inflation statistics, so obviously, a 50% fall in the price of oil would be reflected in the rapid decline in headline inflation. However, we see this as more temporary in nature. Unless the price of oil falls another 50% from where it is currently, these effects will likely roll off by the end of this year, and the underlying dynamics of improving demand should actually start to reverse some of the inflation numbers. So, we think the market may be getting lulled into a sense of comfort as headline inflation numbers have been coming down. We don’t expect that to last, and believe investors should be very wary of taking too much interest-rate exposure in this type of environment.

US Economic Growth and Monetary Policy: Will the Fed Pull the Trigger on Rates?

We think the Federal Reserve (Fed) will likely start normalizing interest rates in 2015. And while it’s true that there’s been a lot of focus on the fact that wage rates are not rising as much as the Fed would like them to, it’s important not to look just at the rate of increase in wages, but also to look at the aggregate labor bill. To do that, you need to look not just at the wage rate, but at the number of people working and the hours they are working. If you look at that number for aggregated labor earnings, it is significantly higher than it was prior to the 2007–2009 financial crisis. Looking at real disposable income, there are also a number of metrics that have all significantly exceeded their pre-crisis levels. There certainly have been some dislocations in the labor market, but we don’t think the excessively easy interest rates that the Fed has been running for years are still justified today.
Europe: Headwinds and Tailwinds

Europe certainly faces a number of headwinds, including large structural impediments in the labor and product markets, and a lack of coordination between a number of economies in the region. In our view, those impediments are unlikely to change significantly in 2015, but they are all largely baked into market expectations and predictions of 2015 growth.

However, there are some important tailwinds that we think the market may be ignoring, which could result in some upside surprises when it comes to Europe’s outlook. The first and most meaningful is the euro currency depreciation. We expect it to continue to depreciate as the European Central Bank (ECB) embarks on a very aggressive quantitative easing (QE) program. This currency depreciation should boost exports, and we expect it to have a meaningful inflow, or feed-through, into European growth. Strong consumer demand from the United States should provide an additional tailwind in boosting European exports.

Another tailwind for Europe is the aforementioned decline in oil prices. As an oil importer, the eurozone should benefit in aggregate from lower oil prices. The IMF estimates that the incremental impact on euro area growth from such a reduction in oil prices could be as much as 0.5%.1 The ECB has a more conservative forecast, but we think the key factor remains that the decline in oil prices will support growth—adding to the potential for an upside surprise to expectations of the region remaining mired in stagnation in the year ahead. These factors put us squarely at odds with currently perceived wisdom that sees the eurozone as the source of global growth fears, and thus in part the cause of the collapse in oil prices due to an impending decline in demand.

Abenomics: A Report Card for Japan

Japanese GDP growth should rebound to over 1% this year,2 above potential, thanks to the expansionary macroeconomic policy and favorable external environment. The IMF estimates that a 50% reduction in oil prices would likely raise Japan’s GDP by up to about 0.5% in 2015.3 A certain degree of uncertainty accompanies this estimate given the clear increase in oil imports after the Fukushima earthquake in 2011. The positive growth impact will likely be gradual and materialize with some quarters’ lags.

The question remains whether this begins a temporary or permanent exit from Japan’s cycle of deflation, rising debt and declining growth. The answer will depend on whether Prime Minister Shinzō Abe’s government manages to make equally decisive progress on other key reforms.

Abstracting from the impact of oil prices, we recognize that the efficacy of Abenomics, the Japanese macro policy experiment in place since early 2013, generates some skepticism. We believe Abenomics—the name given to Prime Minister Shinzō Abe’s ambitious, three-pronged policy to jump-start growth and inflation in Japan that includes QE—needs to be broken down into two components: the short term and the medium to longer term. In the short term, we think Abenomics has been successful. The risk of deflation in Japan has decreased massively; some observers estimate that the risk of deflation in Japan is currently lower than for most other economies globally. Amid a lowering of real interest rates, Abenomics has also been successful in boosting asset prices and depreciating the yen. We see these as signs of success for the first phase of Abenomics.

We think what will determine whether Abenomics is ultimately successful over several years will have to do with structural reform. We need to see labor market reform and product market reform in Japan, as well as increases in the tax regime, in order to make Japan’s debt sustainable, in our view. So we think the first phase has been successful, and Abe has been a very astute political tactician. He sequenced his reforms to maintain his political popularity, which gives him the legitimacy to undertake the type of reforms that will not be very popular going forward. We believe the sequencing from a political standpoint has been very successful, and Abe deserves a lot of credit for that. It remains to be seen if he can use that political legitimacy to execute the longer-term and very difficult reforms that are necessary to get Japan’s debt-to-GDP on a more sustainable path.

In summary, over the past few months, global financial markets have been broadly influenced by the pickup in growth in the United States, the economic stabilization in China, and the abundance of global liquidity from the Bank of Japan and the ECB—which should remain focal points in 2015.

The core of our strategy for 2015 continues to be positioning to navigate an anticipated rising-rate environment in the United States. We have continued to prefer short portfolio duration while aiming for a negative correlation with US Treasury returns. We also actively seek opportunities that can offer positive real yields without taking undue interest rate risk. We maintain our conviction in a strengthening US dollar against the yen and euro and continue to look for investment value in the currency and bond markets of select emerging-market economies.

* Dr. Hasenstab and his team manage Templeton’s global bond strategies including unconstrained fixed income, currency and global macro. This economic team, trained in some of the leading universities in the world, integrates global macroeconomic analysis with in-depth country research to help identify long-term imbalances that translate to investment opportunities.

Dr. Hasenstab’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

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All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Currency rates may fluctuate significantly over short periods of time, and can reduce returns. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. Investments in lower-rated bonds include higher risk of default and loss of principal. Changes in interest rates will affect the value of a portfolio and its share price and yield. Bond prices generally move in the opposite direction of interest rates. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.

1. Source: International Monetary Fund.

2. Source: Bank of Japan.

3. Source: International Monetary Fund.

]]>http://global.beyondbullsandbears.com/2015/02/26/hasenstab-global-growth-headwinds-tailwinds/feed/0Complexity, Critical States and Tributaries of Uncertaintyhttp://global.beyondbullsandbears.com/2015/02/24/complexity-critical-states-tributaries-uncertainty/
http://global.beyondbullsandbears.com/2015/02/24/complexity-critical-states-tributaries-uncertainty/#commentsWed, 25 Feb 2015 03:09:51 +0000http://global.beyondbullsandbears.com/?p=7359For long periods of time, the markets can advance relatively smoothly until a sudden onset of chaos occurs, a “tipping point” that quickly changes the picture. Some might say the recent drop in oil would be a case in point. Brooks Ritchey, senior managing director at K2 Advisors, Franklin Templeton Solutions, explores the tipping points that trigger dramatic market turns, and ponders whether he thinks global equities may be teetering on the edge of one today. J. Brooks Ritchey Senior Managing Director at K2 Advisors, Franklin Templeton Solutions In the March 2010 issue of Foreign Affairs Journal, Harvard history professor Niall Ferguson published a terrific article (IMHO) outlining the complexity of systems and the interaction of forces as it relates to the rise and fall of great societies throughout history. In it he described how large empires could be defined as complex systems that are “asymmetrically organized,” meaning their construction more resembles a termite hill than an Egyptian pyramid. As complex systems, these societies tended to share certain observable and ubiquitous features. These included the interaction of many dispersed agents, multiple levels of organization, sometimes a lack of central control, continual adaptation, incessant creation of new niches and the absence of uniformity. The author went on to describe how these systems operated somewhere between order and disorder—on “the edge of chaos” as he suggested—appearing quite stable for long periods and seemingly in a state of equilibrium. Eventually, however, this observable equilibrium would be disrupted. Very often it would be an ostensibly small event or action, a “tipping point,” that would trigger a meaningful disruption. Scientists define this notion of “edge of chaos” as being in a “critical state” or near “phase transition,” such as the moments prior to water turning to steam or ice, or just before a nuclear reaction. This concept is not exclusive to the academic halls of science, however, nor is it restricted to applications related to states of matter and energy. These “tipping points” leading to “phase transitions”—sometimes insignificant and sometimes world changing—surround us every day in the interactions and activities of our collective experience. They are at work in the earth’s crust when shifting tectonic plates lead to an earthquake in California, in society when the courageous decision of a heroic black woman to no longer sit unjustly at the back of a bus leads to a paradigm shift in civil rights and cultural thinking, and of course in stock markets where home foreclosures in Nevada end with the bankruptcy of one of the most staid and iconic financial institutions on Wall Street. Tipping points and phase transitions are everywhere and always, and could happen upon us at any moment in any circumstance. In terms of the markets, our world could easily be assessed as one that is perpetually on the brink of phase transition, or as described by economist John Mauldin in a “state of stable disequilibrium.” That is to say that participants from all over the world are connected inextricably together in a complex and layered loom of investments, debt, trade, globalization, international business, finance, currency and banks. All operate in a critical yet stable state, in between periods of market rest (low volatility and bull runs) and reaction (high volatility and bears). So this then begs the question, what are the sorts of tipping points that may trigger a market phase transition? Are they observable? Can they be monitored and anticipated? Sand Piles In the book Ubiquity: Why Catastrophes Happen (Crown Publishing, 2002) social scientist Mark Buchanan explores the concepts of complexity theory, chaos theory and critical states. While not directly addressing investments, the book does provide some insight and understanding as to why financial markets can seemingly advance for long periods relatively smoothly, sometimes years, until a sudden onset of chaos or Nassim Taleb’s “Black Swan”-type of events emerge, triggering market corrections or crashes. The book describes the work of three physicists studying in 1987 at the Brookhaven National Laboratory on Long Island. The physicists, Per Bak, Chao Tang, and Kurt Wiesenfeld, used a computer program to create a virtual sand pile. The program was designed to stack one virtual grain of sand at a time and monitor the results, with an eye toward studying “non-equilibrium systems,” i.e., the crazy world that surrounds all of us every day—Wall Street notwithstanding. Over the course of their experiment the physicists learned some really interesting things. One might assume that they would have been able to observe some sort of pattern-like behavior in the sand pile, such as a typical size or number of grains required before a collapse, but this was not the case. On the contrary, each time the experiment was run the results were completely chaotic in their unpredictability. After a large number of tests with millions of grains of sand, they observed no patterns, no typical number required to trigger a system collapse. Sometimes it was a single grain, others 10, 100 or 5,000. Still others involved massive mountains of sand incorporating millions of grains that would collapse in a single and seemingly random onset of failure. In other words literally anything, at any time, might be just about to occur. Perpetually on the brink of phase transition. This kind of stuff sticks with me when I think of the markets … and positioning portfolios. In an attempt to gain some insight into the cause of such unpredictability in their sand pile game—or in an effort to assign some order to the disorder they observed—the scientists pushed their experiment further. Now they looked at the virtual sand pile from above, and they color coded its regions according to steepness, with relatively flat areas green and steeper sections red. In the beginning the pile was mostly green of course (though it still would collapse periodically) but as the game progressed more red areas began to infiltrate, until eventually a dense skeleton of random red danger spots coursed through the sand like tributaries in the Mekong Delta. This offered some insight...]]>

For long periods of time, the markets can advance relatively smoothly until a sudden onset of chaos occurs, a “tipping point” that quickly changes the picture. Some might say the recent drop in oil would be a case in point. Brooks Ritchey, senior managing director at K2 Advisors, Franklin Templeton Solutions, explores the tipping points that trigger dramatic market turns, and ponders whether he thinks global equities may be teetering on the edge of one today.

In the March 2010 issue of Foreign Affairs Journal, Harvard history professor Niall Ferguson published a terrific article (IMHO) outlining the complexity of systems and the interaction of forces as it relates to the rise and fall of great societies throughout history. In it he described how large empires could be defined as complex systems that are “asymmetrically organized,” meaning their construction more resembles a termite hill than an Egyptian pyramid. As complex systems, these societies tended to share certain observable and ubiquitous features. These included the interaction of many dispersed agents, multiple levels of organization, sometimes a lack of central control, continual adaptation, incessant creation of new niches and the absence of uniformity. The author went on to describe how these systems operated somewhere between order and disorder—on “the edge of chaos” as he suggested—appearing quite stable for long periods and seemingly in a state of equilibrium. Eventually, however, this observable equilibrium would be disrupted. Very often it would be an ostensibly small event or action, a “tipping point,” that would trigger a meaningful disruption.

Scientists define this notion of “edge of chaos” as being in a “critical state” or near “phase transition,” such as the moments prior to water turning to steam or ice, or just before a nuclear reaction. This concept is not exclusive to the academic halls of science, however, nor is it restricted to applications related to states of matter and energy. These “tipping points” leading to “phase transitions”—sometimes insignificant and sometimes world changing—surround us every day in the interactions and activities of our collective experience. They are at work in the earth’s crust when shifting tectonic plates lead to an earthquake in California, in society when the courageous decision of a heroic black woman to no longer sit unjustly at the back of a bus leads to a paradigm shift in civil rights and cultural thinking, and of course in stock markets where home foreclosures in Nevada end with the bankruptcy of one of the most staid and iconic financial institutions on Wall Street.

Tipping points and phase transitions are everywhere and always, and could happen upon us at any moment in any circumstance. In terms of the markets, our world could easily be assessed as one that is perpetually on the brink of phase transition, or as described by economist John Mauldin in a “state of stable disequilibrium.” That is to say that participants from all over the world are connected inextricably together in a complex and layered loom of investments, debt, trade, globalization, international business, finance, currency and banks. All operate in a critical yet stable state, in between periods of market rest (low volatility and bull runs) and reaction (high volatility and bears).

So this then begs the question, what are the sorts of tipping points that may trigger a market phase transition? Are they observable? Can they be monitored and anticipated?

Sand Piles

In the book Ubiquity: Why Catastrophes Happen (Crown Publishing, 2002) social scientist Mark Buchanan explores the concepts of complexity theory, chaos theory and critical states. While not directly addressing investments, the book does provide some insight and understanding as to why financial markets can seemingly advance for long periods relatively smoothly, sometimes years, until a sudden onset of chaos or Nassim Taleb’s “Black Swan”-type of events emerge, triggering market corrections or crashes.

The book describes the work of three physicists studying in 1987 at the Brookhaven National Laboratory on Long Island. The physicists, Per Bak, Chao Tang, and Kurt Wiesenfeld, used a computer program to create a virtual sand pile. The program was designed to stack one virtual grain of sand at a time and monitor the results, with an eye toward studying “non-equilibrium systems,” i.e., the crazy world that surrounds all of us every day—Wall Street notwithstanding. Over the course of their experiment the physicists learned some really interesting things. One might assume that they would have been able to observe some sort of pattern-like behavior in the sand pile, such as a typical size or number of grains required before a collapse, but this was not the case. On the contrary, each time the experiment was run the results were completely chaotic in their unpredictability. After a large number of tests with millions of grains of sand, they observed no patterns, no typical number required to trigger a system collapse. Sometimes it was a single grain, others 10, 100 or 5,000. Still others involved massive mountains of sand incorporating millions of grains that would collapse in a single and seemingly random onset of failure. In other words literally anything, at any time, might be just about to occur. Perpetually on the brink of phase transition.

This kind of stuff sticks with me when I think of the markets … and positioning portfolios.

In an attempt to gain some insight into the cause of such unpredictability in their sand pile game—or in an effort to assign some order to the disorder they observed—the scientists pushed their experiment further. Now they looked at the virtual sand pile from above, and they color coded its regions according to steepness, with relatively flat areas green and steeper sections red.

In the beginning the pile was mostly green of course (though it still would collapse periodically) but as the game progressed more red areas began to infiltrate, until eventually a dense skeleton of random red danger spots coursed through the sand like tributaries in the Mekong Delta. This offered some insight into the peculiar behavior (though no real predictability), as a grain of sand falling on a red spot could, by domino-like action, cause a sliding at other nearby red spots.

If the red network was sparse and all trouble spots were well isolated, then a single grain would likely have only limited repercussions if any; again, the triggering was random. But as the red spots began to grow and interconnect the impact of the next grain would become fiendishly unpredictable. Sometimes it fell innocuously and did nothing to the pile, sometimes a few grains tumbled, and every so often it set off a cataclysmic reaction sending walls of sand cascading down the entire pile.

Tributaries of Uncertainty

The author defines these as fingers of instability, but I prefer to consider them tributaries of uncertainty, and not for any copyright infringement risk or pride of authorship, but because “instability” implies, in a way, that an avalanche is imminent, when in fact the experiment showed there is no rhyme or reason. Things can happen just as easily as they cannot. The point being that we are always uncertain, and so we must always be prepared and sheltered appropriately for living in the uncertain world, investment portfolios notwithstanding.

If we did learn anything from the sand pile experiment it is that while we cannot predict what grain of sand may trigger the next phase transition, we can get a sense of the potential size and scope of any imminent disruption to the pile by looking at the steepness and the interconnectedness of the tributaries.

In terms of steepness of the market sand pile, there are ample data that we can observe that illustrates—both literally and figuratively—there is much surrounding us today. That said, we can observe that a significant number of tributaries of uncertainty throughout the pile appear quite extended.

So what about market interconnectedness, the other factor in the sand experiment? Unfortunately quantifying market interconnectedness is a bit more difficult from a data analysis standpoint. If there is a resonant lesson from periods of chaos such as 2008, 1987, etc., however, it is the understanding that things that do not correlate in normal conditions can and often do when sand castles crumble. That much we can be certain of.

The bottom line is that, while I cannot see the future, I do not believe the global marketplace is going to experience a major crash anytime soon (ideally never). Indeed, I am actually optimistic about prospects for equities this year. Nonetheless, I feel markets getting more fragile and volatile as the years move on. On some days it just feels spooky, and certainly not the time to be a full-on bull across the board. The markets today are like nothing they were even 10 years ago. That is not to say they are riskier, because again that is such an abstract and immeasurable quantity to gauge in aggregate that no one could ever know. But it is fair to say they are more complex, even by 2008 standards. The number of participants, assets under management, trading strategies, number of tradable instruments, the light-speed at which information is moved and processed … all of these are grains of sand building the pile. When things go wrong in a complex system, the scale of disruption is nearly impossible to anticipate. There is no such thing as a typical or average forest fire, for example. To use the jargon of modern physics, a forest before a fire is in a state of “self-organized criticality”: it is teetering on the verge of a breakdown pending a spark, but the size of the breakdown is always unknown.

I do not know if the divergence we see among central banks in the world will continue. I have no idea if commodity prices will continue to collapse or if a rapid gain in US dollars versus foreign currencies will spark further deflation and contagion. Are 30-year lows in bond market yields hinting at an economic sinkhole?

The one thing I do know—and firmly believe— is that it is imperative to build a portfolio that is effectively hedged and diversified.

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